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Tuesday, July 24, 2012

Risk is a much debated topic not only in the
financial world, but also in the real business sphere and in our personal lives.
Thus nothing is worth more than defining in the first place what risk means.

When we study statistics, risk is defined by
standard deviation, which can be measured as the deviation from the mean of the
sample or the universe. Although, in the CAPM model risk is estimated through
beta. It can be defined by the covariance of the returns of a particular asset
against a benchmark divided by the product of de standard deviations of each.
Following this rationale:

beta > 1, asset is riskier than the
benchmark

beta = 1, asset is as risky as the benchmark

beta < 1, asset is less riskier than the
benchmark

Although, for value investors risk is something
different. They (we) usually think of risk as the probability of having a
permanent capital loss. This is why value investors require margin of safety,
i.e. a considerable discount to the intrinsic value of the business. Legendary investor Ben Graham
used to require at least a 1/3 discount to net nets.

Bottom line: the cheaper, the less risky an asset is. Do not care that much about volatility and beta. Moreover, the better will be your risk adjusted return.